Legislating for LIBOR transition: UK/EU jurisdictional battle or complementary regimes?

The European Commission has published its proposals for an EU legislative solution for the transition of legacy LIBOR contracts.

This announcement follows hot on the heels of recent announcements for similar legislative fixes in the UK (read our blog post: UK Government announces LIBOR legislative fix: summary of proposals and our initial observations) and the US (read our blog post: LIBOR transition: What does the US regulator’s proposed legislative fix mean for UK financial markets?).

In this blog post, we provide an overview of the Commission’s proposals; compare the legislative solutions from the UK, US and EU; and comment on the effect this EU law development is likely to have on LIBOR transition risk. Continue reading

Hong Kong Monetary Authority announces LIBOR transition milestones and provides guidance on prudential issues

The Hong Kong Monetary Authority (HKMA) has issued a circular to announce the key milestones that authorised institutions (AIs) should endeavour to achieve in the transition from LIBOR to alternative reference rates (ARRs).

This follows a statement by the Financial Stability Board (FSB) on 1 July 2020 in which it maintained its long-held view that “firms across all jurisdictions should continue their efforts in making wider use of risk-free rates in order to reduce reliance on IBORs where appropriate and in particular to remove remaining dependencies on LIBOR by the end of 2021”, notwithstanding the Covid-19 outbreak.

As advised by the HKMA, AIs should implement a detailed work plan (by product and by business line) to achieve the milestones. If they anticipate difficulties in achieving the milestones, they should reach out to the HKMA as soon as possible.

This e-bulletin provides an overview of the milestones, as well as recent developments in Hong Kong and internationally. Among other things, the HKMA issued a circular on 23 July 2020 to provide guidance to AIs on the frequently asked questions published by the Basel Committee on Banking Supervision (BCBS) on prudential issues relating to the benchmark reform. Continue reading

UK Tough Legacy Taskforce recommends LIBOR legislative fix: key risks and next steps

The UK’s Tough Legacy Taskforce (Taskforce) has issued a paper on “tough legacy” issues in the transition from LIBOR. In an important intervention, it has recommended a legislative fix for all asset classes and possibly all LIBOR currencies. The scope of the recommendation from the Taskforce is wider than many will have expected, but will be broadly supported by the market.

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LIBOR transition: FCA sets out its expectations for asset managers

The FCA has set out its expectations for asset management firms in a recent ‘Dear CEO’ letter (the Letter), confirming that such firms should be taking proactive steps now, and should be in no doubt that they have a “responsibility to facilitate and contribute to an orderly end to LIBOR”.

This letter follows on from the suite of documents published by the FCA and Bank of England (BoE), together with the Working Group on Sterling Risk Free Reference Rates (RFRWG) earlier this year (see our blog post for more information).

Next steps

Asset management firms should:

  • Reflect on the messages and act – do not wait for instructions from clients. The FCA has noted that this is a market event and solutions will be market-led. Firms should not expect or base their transition plans on future regulatory relief or guidance or legislative solutions.
  • Take immediate action to develop and execute an appropriate LIBOR transition plan where you have LIBOR exposures (if a transition plan has not already been prepared). This may include revising Senior Managers’ Statements of Responsibilities. Your transition plan must be board approved and supervised.
  • Inform the FCA immediately if the Board considers that a barrier to transition is “insurmountable” or if preparations will not be completed in time.
  • Monitor the FCA’s Transition from LIBOR’s webpage for further updates.


FCA, BoE and RFRWG targets have a “direct read across” for asset management firms

The papers published in January set out a series of targets over the course of 2020 (and early 2021) for banks and other relevant firms to meet to ensure the smooth transition from LIBOR. In the Letter, the FCA sets out how some of these targets apply to asset management firms.

It may be necessary to change the services and products offered

The Letter makes clear that firms will need to consider what products and services they offer their clients and how LIBOR may impact them.

For example, managing the transition for products such as funds, collective investment schemes and/or segregated mandates which reference LIBOR may involve offering new products that reference alternative rates; or amending existing products to include fall-back provisions or replacing LIBOR with alternative rates.

Where asset management firms invest in products which reference LIBOR, such as bonds, loans, swaps and structured products, firms may need to invest in different instruments, or engage with issuers and counterparties to convert outstanding instruments to alternative rates.

Senior management should be appropriately involved

The FCA and PRA wrote to banks in 2018 to ensure Senior Managers were identified who would oversee the implementation of the transition from LIBOR (Dear CEO Letter on firms’ preparations for transition from LIBOR to risk-free rates published in September 2018).

This Letter confirms that Senior Managers at asset management firms also need to have oversight of the transition process, and firms need to be clear on who has accountability for managing each aspect of the transition. Statements of Responsibility may need to be updated to include responsibilities arising from firms’ transition plans.

Even if firms have little or no LIBOR exposure, the FCA expects Boards to test this view periodically.

Firms must still manage conflicts of interest

The Letter makes clear that while transitioning clients from LIBOR, all clients should be treated fairly and should have their interests upheld throughout the process. Conflicts of interest must be mitigated or managed appropriately, and clients should not be exposed to unpredictable or unreasonable costs, losses or risks.

What to consider when preparing transition plans

The FCA considers that firms’ transition plans should be prepared across business functions, and based on engagement with wider transition efforts in the market. Firms will need to fully understand and quantify how their operations are vulnerable to LIBOR cessation (the FCA acknowledges that LIBOR is embedded in a wide range of systems), consider how LIBOR exposures can be addressed, and ensure that clients are kept updated.

Progress throughout execution of the transition plan should be monitored to ensure exposures are decreasing over time to meet the necessary targets.

Clive Cunningham
Clive Cunningham
Partner, London
+44 20 7466 2278
Nish Dissanayake
Nish Dissanayake
Partner, London
+44 20 7466 2365
Nick May
Nick May
Partner, London
+44 20 7466 2617
Emma Reid
Emma Reid
Associate, London
+44 20 7466 2633
Patricia Horton
Patricia Horton
Professional Support Lawyer, London
+44 20 7466 2789

FCA publishes Dear CEO letters to asset managers and alternative investment firms

The FCA this week published two template ‘Dear CEO’ letters, one to asset managers and one to alternative investment firms, highlighting the FCA’s views on the key risks posed to customers and markets, and setting out its supervision strategy for the coming months.

The FCA’s asset management portfolio comprises firms that predominantly directly manage mainstream investment vehicles, or advise on mainstream investments (excluding wealth managers and financial advisers), whilst its alternatives portfolio is comprised of firms that predominantly manage alternative investment vehicles (such as hedge funds or private equity funds) or alternative assets directly, or advise on those types of investments of investment vehicles.

The FCA’s key concern is that standards of governance in both sets of firms are below what it expects, and progress is needed in both sectors to protect the best interests of customers.

Next steps:

The ‘Dear CEO’ letters make it clear that the FCA will be very active in the asset management and alternatives sectors in the coming months, and firms should expect increasing scrutiny. It will be important for firms to look at the areas identified by the FCA and consider any changes they need to make.

Supervision strategy:

The FCA’s supervision strategy addresses the key issues in each sector, with specific priority areas set out below. Whilst the areas of focus are split between the two sectors, the FCA recognises that there will be overlap between the two.

Asset management:

The asset management supervision strategy will focus on the following key areas:

  • Liquidity management – Authorised Fund Managers (AFMs) are responsible for ensuring effective liquidity management in funds but the FCA warns that there can be a liquidity mismatch in open-ended funds between the terms at which investors can redeem and timescales needed to liquidate assets. The FCA expects firms to take necessary action following recent publications from the FCA and the Financial Policy Committee. This has been a continuing theme in light of the issues experienced by some real estate funds after Brexit and the collapse of the Woodford fund.
  • Firm’s governance – Following the extension of SMCR at the end of 2019, the FCA expects firms to have refreshed their approach to governance and taken the steps necessary to improve it in line with SMCR requirements. The FCA intends to carry out work in H1 2020 focussing on the implementation of SMCR across asset managers.
  • Asset Management Market Study (AMMS) remedies – The FCA published its AMMS Final Report in June 2017 and the consequential rule changes are now in force, including requirements around governing body structure and value assessment on funds. In H1 2020, the FCA plans to undertake work on how effectively firms have undertaken value assessments, with more work envisaged in the future given the breadth of the AMMS reforms.
  • Product governance – Following the introduction of new product governance requirements under MiFID II, the FCA has begun reviewing how effectively these requirements have been implemented by asset managers, and expects to complete this work in early 2020. In parallel, the FCA is also reviewing arrangements whereby funds are managed by ‘host’ Authorised Corporate Directors (ACDs) (AFMs that are not within the group structure of the delegate investment manager), as there are concerns that the ‘host’ ACD may not be undertaking their responsibilities effectively in some cases.
  • LIBOR transition – The FCA is currently gathering information from some asset management firms to enhance its understanding of business models, including their specific exposure to LIBOR risk, and intends to provide further communications on its expectations for LIBOR transition in due course.
  • Operational resilience – Operational resilience remains an area of focus for the FCA for financial services firms as a whole. In the asset management sector specifically, the FCA is conducting technology reviews and ad-hoc reviews of firms’ arrangements and expects to undertake further proactive work in this area. The FCA reminds firms of their obligations under Principle 11 to notify it of any material technology failures or cyber-attacks. For more information on operational resilience in the asset management sector, please see our blog post here.
  • EU withdrawal – With the UK’s exit from the EU approaching, the FCA expects firms to consider how the end of the implementation period will affect both the firm and its customers, and take action to be ready for 1 January 2021.

Alternative Investment Firms:

For alternative investment firms, the FCA’s supervisory priorities are as follows:

  • Investor exposure to inappropriate products or levels of investment risk – Significant levels of investment risk are inherent in alternative investments, so the FCA expects firms in this sector to carefully consider the suitability or appropriateness of these investments for their target investors. Where investors are allowed to ‘opt-up’ to elective professional client status, firms should robustly assess the client’s suitability to be opted-up. The FCA plans to review retail investor exposure to alternative investment products offered by alternatives firms, with a particular focus on firms being aware of who their clients are and acting in their clients’ best interests.
  • Client money and custody asset controls – As part of the retail investor exposure, the FCA also plans to assess whether firms which have client money or asset custody permissions are exercising them in accordance with the Client Assets Sourcebook (CASS) rules.
  • Market abuse – In the FCA’s view, market abuse control across the alternatives sector has “significant scope for improvement”. To that end, the FCA has recently conducted an assessment of the adequacy of market abuse controls in the sector and may invite firms to participate in a similar exercise in future. The FCA reminds firms that it may consider enforcement action for those firms which are found not to comply with Market Abuse Regulation (MAR).
  • Market integrity and disruption – With scope to take significant investment risk in managing their products (ie. credit risk and market risk), the FCA expects alternatives firms to operate robust risk management controls to avoid excessive risk-taking and effectively mitigate against potential harm or disruption to markets. The FCA may choose to undertake in-depth assessments of firms’ controls in future.
  • Anti-money laundering and anti-bribery and corruption – Alternatives firms face a risk of being used to facilitate fraud, money laundering, terrorist financing and bribery and corruption. The FCA intends to review firms’ systems and controls to mitigate this risk, with particular focus on the risks of money laundering and terrorist financing.
  • EU withdrawal – As above, the FCA expects firms to take steps to be prepared for the UK’s exit from the EU at the end of the implementation period on 1 January 2021.

 

Clive Cunningham
Clive Cunningham
Partner
+44 20 7466 2278
Nish Dissanayake
Nish Dissanayake
Partner
+44 20 7466 2365
Stephen Newby
Stephen Newby
Partner
+44 20 7466 2481
Tim West
Tim West
Partner
+44 20 7466 2309
Mark Staley
Mark Staley
Senior Associate
+44 20 7466 7621
Katie McGrory
Katie McGrory
Associate
+44 20 7466 2669

LIBOR transition: Regulators expect firms to accelerate preparations for end-2021

The FCA and PRA have confirmed that the next 12 months will be a critical period in transitioning away from the use of LIBOR, advising firms to accelerate their efforts to cease reliance on LIBOR by end-2021. The regulators will step up engagement with firms on LIBOR transition and have contacted senior management responsible for overseeing the transition to set out their expectations for the coming months.

In a suite of documents published last week, the Working Group on Sterling Risk Free Reference Rates (RFRWG), together with both regulators and the Bank of England (BoE), set out the priorities and other actions market participants should take to reduce LIBOR exposure. The documents published include:


Milestones for transition

The documents include the RGRWG’s key milestones and targets for firms over the coming months (see timeline below).

The UK regulators both fully support the timeframe proposed by the RGRWG. The FCA and BoE have also published a statement encouraging market makers to change the market convention for sterling interest rate swaps from LIBOR to SONIA from 2 March 2020.

Alongside these key milestones, the RGRWG will continue its own education, awareness and communication campaigns.


Key regulatory expectations

The key message from these publications is that sterling LIBOR is expected to cease to exist after the end of 2021, and no firm should plan otherwise. Transition plans should cover firms’ stock of legacy LIBOR-linked contracts, as well as new contracts entered into from this year onwards.

Firms should also note several other regulatory expectations highlighted in the documents, including:

Firms should engage proactively with clients and market initiatives

Market participants should be taking appropriate steps to establish that their clients are aware of the risks if new LIBOR transactions are entered into. This expectation to support clients is also brought out in the statement on the use cases of benchmark rates, where the RFRWG suggests within a decision tree that all clients (except large corporates where the transaction size is £25 million or greater) may need to explore with their bank contacts alternatives to compounded SONIA (such as BoE base rates or fixed rates) which are better suited to their needs.

Regulators also expect all firms to play their part in meeting the targets by actively engaging in transition efforts in the market. While progress has been made to date, regulators expect to see clear evidence of engagement from firms from the beginning of Q1 2020.

Senior management should be tracking progress

Senior management should ensure that the management information they receive in respect of LIBOR transition plans tracks performance against targets. This will be relevant to all firms for whom the transition from LIBOR is relevant, but will be particularly important for the senior managers at banks and insurers who have been identified as responsible for overseeing the implementation of the transition plans (in accordance with the FCA and PRA’s Dear CEO Letter on firms’ preparations for transition from LIBOR to risk-free rates and feedback statement published in September 2018 and June 2019, respectively).

Action is expected in key areas and should feature in firms’ planning from Q1 2020

Action in the following areas has been highlighted as being key to delivery and is expected to feature in firms’ planning from Q1 2020: product development; reviewing infrastructure (including updating loan system capabilities); client communications and awareness; and updating documentation.

Firms should be mitigating the risks from the transition

The FCA and PRA are aware that firms are transitioning at different rates, but all firms need to be proactive in taking early action to mitigate the risks from transition.


Increased focus on supervisory powers

The publications from the FCA and BoE make clear that they intend to make use of their supervisory powers if firms are seen to be falling short of their expectations.

In the letter to senior management, the regulators reminded firms that the Financial Policy Committee (FPC) will “keep the potential use of supervisory tools under review“. Firms will need to show sufficient progress by mid-2020 to avoid the FPC seeking recourse to such supervisory tools.

 

Clive Cunningham
Clive Cunningham
Partner, London
+44 20 7466 2278
Nick May
Nick May
Partner, London
+44 20 7466 2617
Emma Reid
Emma Reid
Associate
+44 20 7466 2633
Patricia Horton
Patricia Horton
Professional Support Lawyer
+44 20 7466 2789

Be on the mark – APAC central banks release study of benchmark reform implications

On 24 September 2019, the Executives’ Meeting of East Asia-Pacific Central Banks (EMEAP) published its study on the implications of benchmark reform across the East Asia and Pacific region (Study), including the effects of LIBOR discontinuation, the EU Benchmarks Regulation (BMR) and the ongoing reform of local benchmarks.

The Study provides important insight into market participants’ varying levels of awareness of and preparedness for benchmark reform, as well as valuable guidance as to future regulatory developments we are likely to see from regulators keen to ensure regional markets are well equipped to handle these reforms. The Study also refers extensively to Herbert Smith Freehills’ market-leading work on the BMR with ASIFMA.

Continue reading

HKMA turns up the heat and announces consultation on IBOR transition

On 12 February 2019, the Hong Kong Monetary Authority (HKMA) announced in a briefing to the Legislative Council Panel on Financial Affairs that the Treasury Markets Association (TMA) will hold a long-awaited consultation this quarter on alternative reference rates.

The announcement follows signals from regulators globally that firms should transition away from the London Interbank Offered Rate (LIBOR) and other IBORs to alternative, risk-free, reference rates.

While there is no immediate plan to discontinue the Hong Kong Interbank Offered Rate (HIBOR), the HKMA noted that “as a FSB member, [the HKMA] has an obligation to put in place an alternative reference rate as a contingent fall-back”, tentatively suggesting the HKD Overnight Index Average (HONIA) as the most suitable alternative. Click here to read more.